Monopoly Behaviour of Firms: Characteristics, Occurrence and Other Details

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Monopoly Behaviour of Firms: Characteristics, Occurrence and Other Details!

The usual meaning of a monopoly is a ‘sole supplier of a product having 100% share of the market’. This is often referred to as a pure monopoly and we would concentrate on the same only. Some governments define a monopoly as a firm that has 25% or more share of the market and a dominant monopoly, when a firm has a 40% share of the market.

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Characteristics of a Monopoly:

i. The firm is the industry. It has a 100% share of the market.

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ii. There are high barriers to entry and exit, making it difficult for other firms to enter the market.

iii. A monopoly is a price maker. Its output is the industry’s output and so changes in its supply affect the market price.

Occurrence of Monopolies:

It may be worthwhile to consider the causes which lead a firm to have total control of a market. In some cases, a monopoly may develop over time. One firm may have been so successful in cutting its costs and responding to changes in the consumer tastes in the past, that it has driven out rival firms and captured the whole of the market. Also, mergers and takeovers may result in the number of firms being reduced to one.

Alternatively a monopoly may exist from the start. One firm may own, for instance, all the gold mines in a country or it may have been granted monopolistic powers by a government which makes it illegal for other firms to enter the market. A patent would also stop other firms from producing the product.

Why do Monopolies Continue?

Another pertinent question to be asked is ‘What stops new firms from breaking into the market and providing competition to a monopoly?’ It is the existence of barriers to entry and exit. One type of barrier is a legal barrier. This may be in the form of a patent or a government act.

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Another important barrier to entry is the scale of production. If the monopoly is producing on a large scale, it may be able to produce at a low unit cost. Any new firm, unable to produce as much, is likely to face higher unit cost and hence will be unable to compete.

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It can also be expensive to set up a new industry, if large capital equipment is required. Other barriers to entry include the creation of brand loyalty through branding and advertising and monopoly’s access to resources and retail outlets.

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Barriers to exit can also stop new firms from entering the market. One barrier to exit may be a long-term contract to provide a product. Some firms may be reluctant to undertake such a commitment. A significant barrier to exit is the existence of sunk costs. These are the costs, such as advertising and industry specific equipment, which cannot be recovered if the firm leaves the industry.

The Behaviour of a Monopoly:

The existence of barriers to entry means that a monopoly can earn supernormal profits in the long run. Firms outside the industry may not be aware of the high profits being earned. Even if they do know about the high profits and want to enter the industry, they are kept out by the high barriers to entry and exit.

A monopoly has control over the supply of the product but though it can seek to influence the demand, it does not have control over it. In fact, a monopoly has to make a choice. It can set the price, but then it has to accept the level of sales, consumers is prepared to buy at that price.

If, on the other hand, it chooses to sell a given quantity, the price will be determined by what consumers are prepared to pay for this quantity. Fig. 1 shows that if a firm sets a price P, the demand curve determines that it will sell amount Q. If it decides to sell amount Q1, it will have to accept a price of P1.

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The Performance of a Monopoly:

Monopolies are often criticised. This is because there are concerns that the absence of competition may lead to inefficiency. A monopoly may restrict the supply to push up prices and may produce a poor quality product, knowing that consumers cannot switch to rival products. It may also fail to respond to changes in consumer tastes and develop new products.

It is possible, however, that a monopoly could be relatively efficient and actually benefit consumers. If it produces on a large scale, its unit cost and price may be lower than that in a more competitive market. In fact in some cases a monopoly would definitely be more efficient than competition.

This would be the case when it prevents the wasteful duplication of capital equipment. For instance, it would be expensive and possibly unsafe to have a number of different firms lying and operating rail tracks. A monopoly’s high profits would also enable it to spend on research and development and therefore, it may introduce new, improved variations.

Although it does not have direct competitive pressure to do this, it knows that it will receive all the profits resulting from any successful introduction of new methods and products. In addition, the need to overcome barriers to entry and break the monopoly may encourage firms outside the industry to try and develop a better product.